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The Bubble According to Todd

posted by Adam Levitin

Todd Zywicki has a long blog post criticizing the CFPB's Qualified Mortgage (QM) rule and using it as a jumping-off point for a call to transform the CFPB's leadership from a single Director to a commission.  Zywicki's primary criticism of the QM rule is that it fails to address what he believes was the root cause of the mortgage default crisis:  strategic borrower behavior, which he believes needs to be addressed through down payment requirements and real liability for mortgage deficiency judgments, so that there is borrower skin-in-the-game.  As Zywicki sees it, the housing bubble and its collapse as the result of ruthlessly strategic borrowers playing lenders.  In other words, the bubble was a safety-and-soundness problem, not a consumer protection problem.  The lenders were just helpless dopes, fooled by coldly rational borrowers.

The blame the borrowers move we see here is the same one Zywicki pulled during the bankrutpcy reform debates leading up to BAPCPA, and again it is made without an empirical basis.

In the bankruptcy reform debates, Zywicki explained rising filing rates as the result of strategic consumers filing for quickie chapter 7 bankruptcies and managing to slough off debt with little consequence.  No one questions that there were some of these debtors, but there is absolutely no evidence that they were anything but exceptions. Most bankruptcy filers aren't doctors driving around in Corvettes. Yet for Zywicki, these abusive borrowers defined all borrowers.  We see the same story playing out in the Bubble According to Todd.  Once again, without any empirical basis, all borrowers are now declared to have been strategic and cunning and not deserving of protection. 

Let me be clear, I have no doubt that there are some borrowers who acted with cold-blooded calculation about their "put option" with non-recourse mortgages.  But there just isn't any evidence that quantifies the extent of such behavior. The studies using credit reporting data that label defaults on mortgages when other debts are current as "strategic default" clearly overstate the phenomenon because a consumer could have enough cash to pay all bills excluding the mortgage payment because mortgage payments are much larger than other payments and partial payments are generally not accepted on mortgages.  Moreover, consumers will frequently try to pay as many bills as possible, rather than the most important bills. Thus, not making the mortgage payment may enable payment on several other bills.  And if the consumer needs the car to get to work and the credit card to gas the car, then it makes a lot of sense to pay the car and credit card bills before the mortgage as otherwise the consumer won't have an income stream and will default on the mortgage after defaulting on the other bills.  None of this has anything to do with the "put option" for non-recourse mortgages.  (Indeed, how many consumers understand the "put option"?) 

So I have no problem accepting the strategic borrower phenomenon, but there just isn't an evidentiary basis for Zywicki to describe this as the primary mortgage default issue.  Just to illustrate another, consider all of the "liar loans" made during the bubble--loans on which there was no income verification.  Sometimes borrowers deliberately overstated their income; sometimes brokers inflated the numbers given to them by borrowers in order to get the loans funded.  Of course, lenders were very aware of both phenomena (see the Senate's investigative record of WaMu, e.g.), but no one was going to stop while the music was still playing.  

Other borrowers took out loans assuming that they'd be able to refinance or sell once teaser rates expired.  That assumption, of course, didn't hold true once housing prices fell.  Again, lenders understood quite well that underwriting at teaser rates rather than fully indexed rates exposed borrowers to property value decline risk, but they were happy to fund the loans as long as the credit risk could be shifted to MBS investors.  The QM ability to repay rule creates real consequences for engaging in this sort of cavalier lending behavior.  If the lender did not verify the borrower's ability to repay, then all the lender will have is an unsecured claim against the borrower for the balance of the loan, not a lien on the house.  Presumably that will create a strong incentive for lenders not to tolerate liar loans.  

QM is meant to protect borrowers from getting into loans that they cannot repay. That is has a safety-and-soundness spillover effect is a good thing, but QM isn't really about safety-and-soundness, so its failure to protect banks from every form of consumer cunning isn't a shortcoming. Blasting the CFPB for failing to adopt down-payment requirements ignores that the CFPB had no authorization to do so for the QM rulemaking.  Congress directed the CFPB to make a rule about ability to repay, not about strategic default incentives. To criticize an agency for not acting ultra vires is rather strange, especially for a self-professed conservative like Zywicki. (Perhaps he'd have preferred the CFPB to address no-downpayment mortgages separately, using the UDAAP power...) And imagine if the CFPB had included down payment requirements for QM.  It would then get whipsawed on the argument that it was unduly restricting access to credit.  

[Zywicki has a number of other criticisms of the QM rulemaking, all of which are worthy of some discussion, but this is already a reasonably long post, so I'm going to stick with his lead argument about strategic default.]

But enough on QM.  Does the QM rule suggest a commission structure is right, as Zywicki claims? Even assuming, arguendo, that Zywicki is correct in his criticisms of the QM rulemaking, both in terms of its substance and its evidentiary basis, it isn't clear how this supports the argument that the CFPB should have a commission structure rather than a single Director.  All a 5-member commission needs to pass a rulemaking are 3 votes.  Even if the rulemaking is done on the basis of shaky evidence, there still can be three votes.  To be sure, the minority commissioners can write vociferous dissents and try to signal to the DC Circuit that there are problems, like in Business Roundtable v. SEC, but that's no guarantee that the rulemaking will be overturned.  In short, a commission structure doesn't tell us about the evidentiary quality of rulemakings. Surely Zywicki knows this.  So why the push for a commission structure?  

Well, a commission structure would make the CFPB much less likely to actually engage in any sort of regulation of consumer finance, good or bad. Consumer finance politics don't neatly track Dem/GOP lines. With a 5-member commission, there would either be 3 GOP/2 Dems or 3 Dems/2 GOP.  If the former (3 GOP/2 Dems), you would likely see 3-2 or 4-1 votes against most additional regulation, while with the latter (3 Dem/2 GOP), you'd likely also see 3-2 votes against most additional regulation (2 GOP commissioners joined by one industry-sympathetic conservative Dem).  And in such a world, there likely wouldn't even a lot of proposed new regulation put up for votes.  Ultimately, a commission structure squeezes out progressive voices even if that is what the President wants.  Instead, a commission structure with the brokered 3/2 party split ensures a conservative to moderate majority will prevail, regardless of what happens at the ballot box. Zywicki knows this, of course (indeed, his model is the FTC, which since 1980 has hardly been the paragon of regulatory effectiveness), and that's the game he's driving for.  


In reading the long Todd Zywicki blog, it appears that Todd Zywicki believes what occurs today was taught when he was in law school.

A note from the field: I practice in Wisconsin, which has a somewhat complicated mortgage deficiency law -- sort of non-recourse for first mortgages with limited exceptions, recourse otherwise. And virtually **nobody** except specialist lawyers and maybe a few other professionals has any idea what those rules are. Even my foreclosure defendant clients have no clue until I tell them. I have never heard of a home borrower who understood the relevant law and rationally took it into account in a borrowing decision. Also, any relevant consequences are likely to be many years down the road from the purchase, and a significant deficiency is very likely uncollectable anyway. My conclusion is that affecting borrower behavior by tinkering with recourse rules is a total fantasy.

Here is another BLOW HARD shill for the banks. Lets just blame the consumer because they can't defend themselves properly, without the loads of cash the banks have for major PR firms.

These bums won't lend a dime to their own mothers without proof of getting paid back, but its some joe schmo who tricked the big old banks into making the bad loans that they did.

Lets talk about the MBA that strategically defaulted on their debt, or Tisch in NY who walked away from their obligations.

It just makes me sick how our government let these criminals off the hook, with this new round of settlements.

Hey Todd get a life you piece of garbage.

I agree with the comment that no (small) borrowers know the laws before borrowing. They trust the people they deal wit to be fair. BIG MISTAKE!

Great article, I really enjoyed it. In support of your perspective and against the argument that more skin-in-the-game for borrowers would prevent a mortgage default crisis, I might point to the case of Ireland. In that jurisdiction debtors bear real liability for mortgage deficiency judgments, and a draconian bankruptcy law means that there is no debt relief from this obligation. Yet this has not prevented the position (as of December 2012) whereby over 20% of residential mortgages are either in arrears of 90+ days plus, or have been restructured.

If you want the answer to come out a certain way, I guess you can just ignore the evidence.

The trail of the creation of private mortgage backed securities is pretty clear if you don't have an agenda. It was a vicious, skinless cycle of "tell me what value you want" appraisers, "we'd give a triple A rating to a deal structured by cows" rating agencies, investment banks setting up mortgage brokers to bring in any kind of crap that could be repacked and sold to yield chasing hedge funds, foreign investors, and, of course, to Fanny/Freddie.

But, folks like Mr. Z don't need no stinkin' facts. Neocon's think they can create their own reality, at least until the real reality intrudes. . . .

Oh gee, Zywicki shilling for banks, abusing data, and revising history. I'm shocked.

that has been destroyed in recent years, especially in the UK where an expenses scandal thanks to freedom of information almost brought down a government. Combine this with the crisis of confidence in the financial system, and you could believe there is no longer any trust left in our stable institutions of the past.

It seems as if both lenders and consumers bear some fault in this mess. In the beginning it was clear that a loose or non-existent, unenforced lending policy created loans that the borrower was not going to be able to repay.

Then the borrower, seeing that he could "afford" a bigger more expensive house if he got a zero down interest only loan, ran out and overspent.

As the economy tanked, both parties were caught in the net. The borrower bails and simply takes a credit hit. The lender sobs, cries and throws a fit trying to place blame. But, who threw the first log on the fire?

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